UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK
July 31, 1974
In the Matter of KINGSBORO MORTGAGE CORPORATION, Bankrupt
Cannella, District Judge.
The opinion of the court was delivered by: CANNELLA
CANNELLA, District Judge:
This appeal from a decision of Hon. Edward J. Ryan, Bankruptcy Judge, dated March 13, 1974 (summarized at CCH Bankr.L.Rep. para. 65,215) and an order subsequently entered thereon (March 25, 1974), raises the question of whether, pursuant to a valid contractual subordination agreement among creditors, certain senior unsecured creditors may recover "post-petition" interest on their indebtedness prior to and from any dividend allocable to those junior creditors which are party to the subordination agreement. The bankruptcy court answered this question in the affirmative. This Court does not agree and, in light of the recent decision of the Third Circuit in In re Time Sales Finance Corp., 491 F.2d 841 (3 Cir. 1974), the decision below is reversed.
The factual framework giving rise to the present appeal is not subject to dispute among the parties and is presented by Judge Ryan in such fashion as not to require further elaboration here.
Rather, the legal issue raised may be said to turn upon the effect to be given certain language contained in the subordination agreement, the pertinent portions of which serve as point of departure for the present inquiry.
12. Subordination to Senior Debt.
. . .
(b) In the event of any insolvency, liquidation, reorganization or other similar proceedings, or any receivership proceedings in connection therewith, relative to the Company or its creditors or its property, and in the event of any proceedings for voluntary liquidation, dissolution or other winding up of the Company whether or not involving insolvency or bankruptcy proceedings, then all principal and interest on all Senior Debt shall first be paid in full, or such payment shall have provided for, before any payment on account of principal or interest is made upon the Notes [junior debt]. . . .
(d) In any of the proceedings referred to in paragraph (b) above, any payment or distribution of any kind or character, whether in cash, property, stock or obligations which may be payable or deliverable in respect of the Notes shall be paid or delivered directly to the holders of Senior Debt for application in payment thereof, unless and until all principal and interest on all Senior Debt shall have been paid in full. . . .
Judge Ryan, in his determination of the matter, indicated that the aforestated terms of the subordination agreement "clearly [demonstrate that appellant] had in mind precisely the situation now before the Court," and it agreed that "all principal and interest on all Senior Debt shall first be paid in full. . . before any payment on account of principal and interest is made upon the Notes. . . ."
Upon such reasoning, the Judge concluded that "no sound reason has been advanced by the [appellant] why this language should not be given its obvious construction and effect."
In adopting this view, that an allowance of "post-petition" interest to appellee creditors was justified by the contract, the bankruptcy court rejected appellant's contention that Section 63(a)(1) of the Bankruptcy Act, 11 U.S.C. § 103(a)(1),
which restricts proofs of claim founded upon fixed liability to the principal amount of the obligation and any interest thereon which would have been recoverable at the time of the filing of the petition in bankruptcy, as well as those well recognized policy considerations which hold for the cessation of interest accrual as of the date of filing the petition,
served to preclude the allowance of interest sought by the appellees.
Rather, the Judge found the rule stated by the Court of Appeals for this Circuit in In re Credit Industrial Corp., 366 F.2d 402 (2 Cir. 1966), namely, that the "bankruptcy court, in order to effectuate its duty to do equity, must enforce lawful subordination agreements according to their terms and prevent junior creditors from receiving funds where they have 'explicitly agreed not to accept them'",
dispositive of this controversy.
For purposes of the instant appeal, this Court has no quarrel with this analysis of the applicable law.
Departure from Judge Ryan's view is necessitated only because the conclusion reached, that by the subordination agreement appellant "clearly demonstrat[ed]" an intent to allow senior unsecured creditors "post-petition" interest prior to and out of any dividend allocable to it, misconceives the thrust of the relevant decisional authority.
Squarely in point is the recent decision of the Court of Appeals for the Third Circuit in In re Time Sales Finance Corp., supra. In that case, the Court of Appeals affirmed the district court's denial of "post-petition" interest to senior creditors predicated upon a subordination agreement almost identical to that at bar.
In the event of any liquidation, dissolution or winding up of the company or of any receivership, insolvency, bankruptcy, liquidation, readjustment, reorganization or other similar proceedings relative to the company or its creditors or its property, all principal and interest owing on all superior indebtedness of the company shall be paid in full before any payment is made on Five Year Debenture Notes. . . .
Judge Adams, speaking for a unanimous court, stated the rationale for the Time Sales decision in these words:
We need not decide, at this time, whether the narrow group of exceptions to the general rule that "everything stops" at the date the petition is filed is to be expanded to include the situation here. . . .
Instead, the district court's conclusion that the subordination provision contained in the debenture notes did not appropriately apprise the debenture note holders that their claims against the bankrupt would be subordinated to [the senior creditor's] demand for post-petition interest is not incorrect and, thus, is adequate to sustain its order denying [the senior creditor's] claim for post-petition interest. . . . If a creditor desires to establish a right to post-petition interest and a concomitant reduction in the dividends due to subordinated creditors, the agreement should clearly show that the general rule that interest stops on the date of the filing of the petition is to be suspended, at least vis-a-vis these parties.12
Rather than being in conflict with the decision of the Second Circuit in In re Credit Industrial Corp., supra, as appellees contend, Time Sales is in complete accord with the rationale of that earlier case. As was stated, supra, Credit Industrial clearly stands for the proposition that lawful subordination agreements must be enforced in bankruptcy according to their terms and that junior creditors may not receive funds which they have "explicitly agreed not to accept." Time Sales does not deviate from this view nor does it exact a more stringent requirement in instances such as at bar. The rule established by Time Sales, that before a right to "post-petition" interest and a concomitant reduction in dividends to subordinated creditors may be recognized, "the agreement should clearly show that the general rule that interest stops on the date of the filing of the petition is to be suspended, at least vis-a-vis these parties,"
is no more than a rule of "explicitness" wholly consistent with that enunciated in the Credit Industrial case.
On the record before it, this Court can not view the provisions contained in the subordination agreement, which are to the effect that no payment shall be made to the subordinated creditors "unless and until all principal and interest on all Senior Debt shall have been paid in full," when taken in a context of specific reference to "bankruptcy proceedings", as sufficiently clear and explicit as would preclude the operation of the general and accepted rule that "everything stops" on such date as the petition in bankruptcy is filed.
Upon the standard established in Time Sales, precise, explicit and unambiguous language must be contained in the subordination agreement to the effect that the contract abrogates the general rule regarding interest, in order that a right to "post-petition" interest prior to the payment of dividends to junior creditors may be established. Accordingly, the Court concludes that Judge Ryan erred in ruling that the contract at bar "clearly demonstrates" an intent to allow payment of "post-petition" interest.
The decision and order of the bankruptcy court is reversed and the entry of an appropriate order is directed.